There’s been a huge shift towards passive investing in recent years, with passive investments dominating flows. In 2024, European domiciled passive funds saw net inflows of €307.6 billion, a new record high, versus €150.5 billion inflows for active funds. So, it’s no surprise that ETFs and index funds have come up against each other.
Advantages of investing in an ETF
Intraday trading makes ETFs more flexible and allows investors to react quicker. This might be a valuable attribute for investors willing to take shorter-term action or risk.
When it comes to transparency, ETFs have the upper hand by disclosing their holdings daily. This might appeal to more engaged or, again, shorter-term traders.
ETFs use in-kind transfers, which involves exchanging securities for ETF shares rather than cash. This is more tax efficient and reduces costs, so ETFs generally have lower management fees versus index funds. But they do come with trading costs so the total cost of ownership should be considered.
Advantages of investing in an index fund
Index funds have a single valuation point which is suitable for most investors who take a longer-term investment approach.
Unlike ETFs, index funds aren’t required to disclose their holdings daily, but not all investors need this level of transparency and may value simplicity over granularity.
Index funds typically avoid trading costs, such as dealing charges and spreads, so there’s less for investors to consider compared to investing in ETFs.
Battle of the trackers
In theory, ETFs should perform better than equivalent index funds because of their tax efficiencies and lower fees. In practice though, there are different factors at play that can impact performance. And different fund managers will use different techniques to keep costs down and performance as close to the index they’re tracking as possible.
The battle between ETFs and index funds comes down to individual preference and what you value as an investor. More active traders may prefer ETFs, but making shorter-term investment decisions can come with additional risk. For long-term investors, index funds can be a suitable option for the core of an investment portfolio.
Investment ideas
Legal & General UK 100 Index fund and iShares FTSE 100 ETF
Two of our favoured passive options in the UK sector – both offer a simple and low-cost way to track the FTSE 100 Index, which includes the UK’s 100 biggest companies.
Legal & General is one of the UK’s leading providers of passive funds and BlackRock, which manages the iShares range of ETFs, has been managing them for over 50 years. Both have plenty of experience in passive investing and have the scale to keep costs down, which means they’re able to provide some of the cheapest passive funds in the market.
Vanguard Global Bond Index fund and Vanguard Global Aggregate Bond ETF
In the Global Mixed Bond sector, these are our preferred passive options. Vanguard is a pioneer when it comes to passive investing and its index funds and ETFs are run by a large global investment team that we rate highly.
Both options provide exposure to thousands of fixed income investments, which make up the Bloomberg Global Aggregate Index, including global government, corporate and securitised bonds, at a low-cost.
By Danielle Farley, passive investment analyst, Hargreaves Lansdown
